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The China Syndrome

Why would the Chinese government pump up their stock market to retail investors?

Short answer—to create a middle class wealth effect and boost the chance for highly indebted companies to refund borrowings through equity issuance.

Never airbrush the Communist Party out of the Chinese markets—for all of the freeing up of individual access there remains an abiding faith in Beijing’s ability to provide a soft landing. And State- owned media’s urging of its citizens to invest took hold—

The Shanghai Stock Market only opened for trading in 1990. For the last six years the Index has been rolling along like a flat prairie decoupled from the steady economic growth of China—making it one of the worst performing markets in the world year after year. Then in June 2104 levitation began and the market surged by over 160% so that the combined stock markets in China were the world’s third largest behind the US Nasdaq.

But there was a difference or two in China. First only 2% of the holdings were by foreigners. And unlike the United States and European bourses where big institutions dominate, most of China’s investment was individual investors.

We are talking retail investors. Over 90 million accounts, and until recently growing rapidly. Fully 20% of those accounts signed up since the May.To put that number into context there are not 90 million members of the Communist Party in China.

We are talking an investor cohort way beyond the educated and elite business class. The ranks of China’s investors are deep into the middle class. One study says 30% of college students are stock market players.

It gets worse. Margin debt by some measures is the highest proportion of any stock market in history. Margin loans to buy stocks surged 400% in the last year. When you consider that 12 million accounts were opened in May alone, it means that millions of Chinese middle-class investors were buying and borrowing heavily just before the peak.

Put another way a huge portion of the $3 trillion in lost market value was in fact borrowed money by middle class Chinese.

These days stocks get frozen after they decline by 10% and cannot be traded. But heavily leverage middle class members need cash to pay back loans—so assets of every kind, especially commodities are facing price decreases as desperate borrowers seek a way to raise money.

What is interesting in contrast to the US response of 2008 is that China is moving every muscle to try and wrestle the middle class investor to a place of calm and restored order. Investors come first, banks and brokerages second.

But markets cannot be controlled, even by a super potent regime prepared to do almost anything to prevent social unrest among its burgeoning investor class.

But watch how the Chinese government and the Peoples Bank of China (PBOC) maneuver to protect these investors. Sadly they cannot put a Nerf Ball under every individual account. Lowering interest rates multiple times, pressuring brokerage firms to spend billions to reduce downward price pressure, curbing speculative IPO’s and good old fashion “Let’s Not Panic” jawboning will not restore confidence.

Heavily leveraged middle- class Chinese will need to feel pain of their overextension. Until that sense of balance between borrowing and asset values is restored to individuals their market will be volatile—particularly because there are far fewer alternative purchasers consistent with mature markets of the West. No hedge funds to the “rescue”.

No amount of party persuasion can restore confidence like the bottoming price action of a flagging bear run—and that has yet to occur. Chinese investors need a cleansing. That only comes when values become attractive again at lower levels. That is the first step to restored order.

It may well be that the Chinese stock market begins to reflect the individual economics of the Chinese middle class more closely than it has in the past. But China itself has weathered many threats during the nearly 30 years it has been an economic force of nature. Never count it out.

True, its total debt is now considered more than twice its GDP—an atmospheric height. But so many of the growth and vital signs as the nation transitions from a manufacturing export monster to a service and software oriented economy are still present. Many major western brokerages are maintaining a positive outlook on China’s shares over the long term. Many are saying to outright buy on this weakness. The Hang Seng, which is the Hong Kong market, has been more muted on the surge up and more measured on the slide down too. But market malaise has a tendency to remain discreet for only so long before underperformance leeches into adjacent stock markets. And the Hang Seng is under pressure.

Here at home watch for major western corporates with major interests in the well-being of the Chinese middle class to suffer temporary setbacks.

But make no mistake, China is transitioning in two powerful ways and it is well along that path. China’s middle class will rise, supported heavily by the central government, and the steady swift and sure shift to a service economy will mark a new path for China in the years to come aimed directly at our middle class—and when the economic outlook and the stock market again converge it will mean higher prices than today’s crumbling action . The choice for us is whether that middle class surge is opportunity or threat.

Read about the world’s growing middle class in National Bestseller American Mojo: Lost & Found by Peter D. Kiernan

The China Syndrome

Why would the Chinese government pump up their stock market to retail investors?

Short answer—to create a middle class wealth effect and boost the chance for highly indebted companies to refund borrowings through equity issuance.

Never airbrush the Communist Party out of the Chinese markets—for all of the freeing up of individual access there remains an abiding faith in Beijing’s ability to provide a soft landing. And State- owned media’s urging of its citizens to invest took hold—

The Shanghai Stock Market only opened for trading in 1990. For the last six years the Index has been rolling along like a flat prairie decoupled from the steady economic growth of China—making it one of the worst performing markets in the world year after year. Then in June 2104 levitation began and the market surged by over 160% so that the combined stock markets in China were the world’s third largest behind the US Nasdaq.

But there was a difference or two in China. First only 2% of the holdings were by foreigners. And unlike the United States and European bourses where big institutions dominate, most of China’s investment was individual investors.

We are talking retail investors. Over 90 million accounts, and until recently growing rapidly. Fully 20% of those accounts signed up since the May.To put that number into context there are not 90 million members of the Communist Party in China.

We are talking an investor cohort way beyond the educated and elite business class. The ranks of China’s investors are deep into the middle class. One study says 30% of college students are stock market players.

It gets worse. Margin debt by some measures is the highest proportion of any stock market in history. Margin loans to buy stocks surged 400% in the last year. When you consider that 12 million accounts were opened in May alone, it means that millions of Chinese middle-class investors were buying and borrowing heavily just before the peak.

Put another way a huge portion of the $3 trillion in lost market value was in fact borrowed money by middle class Chinese.

These days stocks get frozen after they decline by 10% and cannot be traded. But heavily leverage middle class members need cash to pay back loans—so assets of every kind, especially commodities are facing price decreases as desperate borrowers seek a way to raise money.

What is interesting in contrast to the US response of 2008 is that China is moving every muscle to try and wrestle the middle class investor to a place of calm and restored order. Investors come first, banks and brokerages second.

But markets cannot be controlled, even by a super potent regime prepared to do almost anything to prevent social unrest among its burgeoning investor class.

But watch how the Chinese government and the Peoples Bank of China (PBOC) maneuver to protect these investors. Sadly they cannot put a Nerf Ball under every individual account. Lowering interest rates multiple times, pressuring brokerage firms to spend billions to reduce downward price pressure, curbing speculative IPO’s and good old fashion “Let’s Not Panic” jawboning will not restore confidence.

Heavily leveraged middle- class Chinese will need to feel pain of their overextension. Until that sense of balance between borrowing and asset values is restored to individuals their market will be volatile—particularly because there are far fewer alternative purchasers consistent with mature markets of the West. No hedge funds to the “rescue”.

No amount of party persuasion can restore confidence like the bottoming price action of a flagging bear run—and that has yet to occur. Chinese investors need a cleansing. That only comes when values become attractive again at lower levels. That is the first step to restored order.

It may well be that the Chinese stock market begins to reflect the individual economics of the Chinese middle class more closely than it has in the past. But China itself has weathered many threats during the nearly 30 years it has been an economic force of nature. Never count it out.

True, its total debt is now considered more than twice its GDP—an atmospheric height. But so many of the growth and vital signs as the nation transitions from a manufacturing export monster to a service and software oriented economy are still present. Many major western brokerages are maintaining a positive outlook on China’s shares over the long term. Many are saying to outright buy on this weakness. The Hang Seng, which is the Hong Kong market, has been more muted on the surge up and more measured on the slide down too. But market malaise has a tendency to remain discreet for only so long before underperformance leeches into adjacent stock markets. And the Hang Seng is under pressure.

Here at home watch for major western corporates with major interests in the well-being of the Chinese middle class to suffer temporary setbacks.

But make no mistake, China is transitioning in two powerful ways and it is well along that path. China’s middle class will rise, supported heavily by the central government, and the steady swift and sure shift to a service economy will mark a new path for China in the years to come aimed directly at our middle class—and when the economic outlook and the stock market again converge it will mean higher prices than today’s crumbling action . The choice for us is whether that middle class surge is opportunity or threat.

Read about the world’s growing middle class in National Bestseller American Mojo: Lost & Found by Peter D. Kiernan